What is Tax-Loss Harvesting?
What Is Tax-Loss Harvesting?
Tax-loss harvesting is a strategy where you sell investments at a loss to offset capital gains and reduce your tax liability.
Key Tax-Loss Harvesting Rules:
Only for taxable accounts
Losses can offset capital gains dollar-for-dollar
Up to $3,000 per year can reduce ordinary income ($1,500 if married filing separately)
Excess losses carry forward indefinitely
Avoid the wash sale rule: don’t rebuy the same or substantially identical asset within 30 days
You can buy T-Mobile after selling AT&T, but not GOOG for GOOGL.
Accounting Methods Allowed by the IRS:
FIFO (First-In, First-Out) – default method. You sell oldest shares first.
Specific Identification – most tax-efficient, you choose which lots of securities you want to share
Average Cost – allowed only for mutual funds
Use specific identification to target high-cost lots and maximize losses—or low cost lots when harvesting a gain.
What is the benefit of Tax-Loss Harvesting?
Other than being able to take 3k off your taxable income, tax-loss harvesting doesn’t do much in a vacuum. The real benefit of tax-loss harvesting is being able to transfer your tax liability from one security to another, as well as to delay or prevent a year-end tax disaster.
For example:
You gained 100k on Stock A this year
You lost 50k on Stock B this year
You would like to diversify out of Stock A
What you would do in this scenario is sell enough of Stock B to diversify as much as you would like out of Stock A—then you would sell enough of Stock A to fill your tax-loss.
The question you have to ask yourself is: where do you want to put the proceeds from all of that selling?
Conclusion
Tax-loss harvesting is a useful tool for managing your portfolio. It allows you to take advantage of a losing asset in order to reduce your exposure to other assets that have gains. If you get hit with a huge tax bill every year, tax-loss harvesting can also come in handy. The real purpose of harvesting losses is not to reduce your overall tax liability, but to give you flexibility when managing your portfolio.